NEW YORK ( TheStreet) -- Yesterday, innovative ETF provider ALPS launched the High Volatility Put Write Index Fund (HVPW). The strategy underlying the fund is to sell cash-secured naked put options on volatile large-cap stocks to generate an income stream for fund holders.
Selling or writing naked puts is a strategy that succeeds when the underlying stock stays flat or goes up. The risk to the strategy is a large decline in the stock. For example if a stock is trading at $70, an investor might sell a put option with a $65 strike price in exchange for option premium.
If the puts expire and the stock stays at $65 or higher then the puts expire worthless and the investor gets to keep the premium with no other action to take. If the stock goes below $65 before the puts expire, then the investor will very likely be assigned on his put options which means he will have to buy the stock at $65. If the stock is at $64, then it isn't a nightmare but if the stock has dropped to $30 or $40, then being forced to buy at $65 would be a nightmare. That is the risk of the strategy.
More specific to HVPW, the fund will maintain a portfolio of puts sold against 20 volatile stocks. It will sell options that expire in 60 days that are roughly 15% out of the money, and so be able to repeat this six times during the year. The income component will come from the premium brought in from selling the puts. HVPW will seek to pay out 1.5% every 60 days, a 9% yield.
However, before the fund can pay out the 1.5%, it will have to account for the expense ratio of 0.95% annually. Also, any losses from losing put trades will also come from the potential 1.5% income stream.
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